MSc in Project Planning and Management

Development Theories and Practice

CHAPTER FIVE
DETERMINANTS OF DEVELOPMENT
5.1 Introduction
Today, countries of the world are divided into rich (developed) countries and poor
(developing) countries. There is a wide gap between the rich and the poor countries. The
statement that “the rich nations get richer and the poor countries get poorer” has become
popular in the literature in world poverty. But what are the explanations for the poor
performance of the developing countries? There are three approaches to explain the
determinants of development the traditional approach, the institutional approach and the
human capital approach.

5.2 Traditional or Economic Approach to Development

The traditional approach to development assumes that economic development is
determined by economic factors, like natural resources, technology, capital, labor, and
organization. Let’s see each of the major economic factors.

5.2.1 Natural Resources

The principal factor affecting the development of an economy is the natural resources or
land. “Land” as used in economic factor includes natural resources such as fertility of
land, its situation and composition, forest wealth, minerals, climate, water resources, sea
resources, geographical proximity with rich countries etc. For growth, the existence of
natural resources in abundance is essential. A country which is deficient in natural
resources will not be in a position to develop rapidly. As pointed out by Lewis, “Other
things being equal, men can make better use of rich resources than they can of poor.”

In LDCs natural resources are either unutilized, underutilized or misutilized. This is one of
the reasons for their backwardness. The presence of natural resources is not sufficient for
economic growth. What is required is their proper exploitation. It is often said that
economic growth is possible even when an economy is deficient in natural resources. As
pointed out by Lewis, “A country which is considered to be poor in resources today may
be considered very rich in resources at some later time, not merely because unknown
resources are discovered, but equally because new uses are discovered for the known
resources.” Japan is one such country which is deficient in natural resources but it is one
of the advanced countries of the world because it has been able to discover new uses for
limited resources.

5.2.2 Capital Accumulation

Capital means the stock of physical reproducible factors of production. When capital stock
increases with the passage of time, it is called capital accumulation or capital formation.
Capital formation is investment in capital goods that leads to increase in capital stock,
national output and income.

Capital formation is the key to economic development. On the one hand it reflects
effective demand and on the other hand, it creates productive efficiency for production.
Capital formation possesses special importance to LDCs. The process of capital formation
leads to the increase in national output in a number of ways. Capital formation is essential
to meet the requirements of an increasing population in such economies. Investment in
capital goods not only raises production but also employment opportunities. It is capital
formation that leads to technological progress.

Technology in turn leads to specialization and the economies of large scale production.
The provision of social and economic over heads, like transport, power education etc in a
country is possible through capital formation. It is also capital formation that leads to the
exploitation of natural resources, industrialization and expansion of markets which are
essential for economic progress.

5.2.3 Organization
Organization is an important part of the growth process. It relates to the optimum use of
factor of production in economic activities. Organization is complement to capital and
labour and helps in increasing their productive activities. In modern economic growth, the

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entrepreneur has been performing the task of an organizer and undertaking risks and
uncertainties.

The underdeveloped countries lack entrepreneurial activity. Such factors as the small size
of the market, capital deficiency, absence of private property and contract, lack of skilled
and trained labour, non-availability of adequate raw materials and infrastructural facilities
like transport, power, etc increase risk and uncertainties. That is why such countries lack
entrepreneurs.

5.2.4 Technological Progress

Technological charges are regarded as the most important factor in the process of
economic growth. They are related to changes in the methods of production which are the
result of some new techniques of research or innovation. Changes in Technology lead to
increase in productivity of labour, capital and other factors of production.

5.2.5 Division of Labour and Scale of Production

Specialization and division of labour lead to increase in productivity. They lead to
economies of large scale production which further help in industrial development. Adam
Smith gave much importance to the division of labour in economic development. Division
of labour leads to improvement in the productive capacities of labour. Every laborer
becomes more efficient than before, s/he saves time and s/he is capable of inventing new
machines and process in production. Ultimately production increases manifold. But
division of labour depends upon the size of the market. The size of the market, in turn,
depends upon economic progress, i.e. the extent to which the size of demand, the general
level of production, the means of transport etc are developed. When the scale of
production is large there is greater specialization and division of labour. As a result
production increases and the rate of economic progress is accelerated.

Underdeveloped countries are unable to take advantage of division of labour and large
scale production due to the presence of market imperfections, which in turn keep the size
of the market small.

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5.3 Institutional Approach to Development
The institutional approach to development is a recent phenomenon. It argues that
explanations of the poor economic development are found not only in economic factors
but also non-economic factors. In fact most of these factors are explained by non-
economic factors or institutional factors.

The institutional approach to development emphasizes importance of the institutional

factors more than the economic factors using the case of a metropolitan city. The central
city in a metropolitan area, while gaining some high-rise buildings, has a stagnant
population and an increasing proportion of poor people. On the other hand suburbs are
prosperous and growing rapidly.

To a certain degree, modern economics is like such a metropolitan area. The traditional
economics is at the center of the city. At the same time, the suburbs of economics are
expanding rapidly in all directions. The institution approach to development is a case in
point. For example, consider shifting the focus from capital and other resources toward
the quality of governance. In the suburbs of economics, governance is a focus, but not in
the city center where capital is the focus.

The institutional factor further argues that most of the economic factors can be obtained in
the globalize market. For example, many Multi National Corporations (MNCs) are ready
to invest a significant amount of capital if conditions are favorable. Besides LDCs can also
borrow technologies from DCS. The institutional factors that determine economic
performance include.

5.3.1 Type of Government

A country with a monarchy system is less likely to develop as compared with a country
with a democratic government. The nature of democracy depends on the level of
education, discipline, culture etc of the people. In maintaining rules, governments could be
soft or strong. To maintain rules and there by prepare the ground for development,
governments need be strong. To provide for the enforcement of contracts, the prevention
of anarchy, and the provision of other public good, the coercive power of government is
necessary.

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Good governance is another important factor which determinants economic performance
of countries. According to Olson M. “Governance is a decisive determinant of economic
performance and that with the right economic policy and institutions, poor countries can
grow at a very rapid rate.” Good governance is reflected by long tem vision, correct
policies and effective implementation. For example, in Japan the government decided
what type of industries to develop after World War II. It gave emphasis to textile, iron and
steel, shipbuilding etc. In recent years, the government shifted towards electronics in
response to a change in world market. Another aspect of good governance is the
development of infrastructure. Countries like Hong Kong, Singapore, Malaysia, etc
develop infrastructure and attract foreign capital.

5.3.2 Institutions
Availability of technology like the capital good, complementary factors like infrastructure,
highly skilled labor, innovation etc are required for an economy to grow. To have such
technological changes requires a good institution. For example, in making innovations,
there could be resistance. To calm such resistance, government effort is required. Thus,
institutions that encourage technological innovation and suitability of institution for
successful adoption of new ideas is an important question. Political and cultural dynamism
help in adoption of new technology and the negative forces such as labour union
orthodoxy should be managed properly by good governance. Spread of education,
scientific culture are necessary for adoption of new technology.

Reservation/Affirmative Action:- Social justice requires that if some sections of the

society are deprived, they must be given special attention i.e. reservation is needed. The
supporters of reservation justify its use in terms of social justice, equity and to rectify
historical mistakes. However, from the point of view of efficiency, it is not justified.

5.3.3 Social Structure of Population

In some countries, we get a homogenous type of population. Homogeneity of the
population leads to the development of national feelings, which is helpful for economic
development – for example China, Japan, Korea, Russia. On the other hand, population of
a country could also be heterogeneous - divided on the basis of language, religion,

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ethnicity, caste etc. In such societies, some groups play entrepreneurial role. For example,
the Jews in USA.

5.3.4 Human Capital and Cultural Traits

The difference in per capita income among countries could be explained by human capital
and cultural traits. In the DCs, human capital and cultural traits in the form of work
culture, discipline, good entrepreneurship etc have played an important role. Poor
countries are poor because they lack these traits. The cultural traits that perpetuate poverty
are the result of centuries of social accumulation and they can’t be changed quickly.
Cultural advancement according to M. Olson results in two types of human capital:
a) Marketable human capital - these include more skill, propensity to work harder,
more entrepreneurial personality - these qualities result in increase in the
quality and quantity of productive outputs. These results in increase in income
of persons, groups as well as of nations.
b) Civic culture. A civic culture leads to the election of good government which
adopts good policy. It also results in a disciplined society. Corruption will be
less and people pay tax.

5.4 Human Capital Approach to Development

5.4.1 Human Capital Formation
Capital may be human or non-human. Human capital formation refers to the process of
acquiring and increasing the human persons who have the skills, education, abilities and
ideas which are critical for economic and political development of the country. Human
capital formation is thus associated with investment in man and his development as a
creative productive resource. The human capital formation Includes investment on
education, on-the-job training programs, and medical care.
Although human capital formation is a key significance for the development efforts of
mainly less developed countries, its formation bristles with several difficulties. Thus, the
following could be taken as the problems or challenges of human capital formation.
1. Population explosion: the rapid growth of population in developing countries hinders
the human capital formation as it imposes an adverse impact on the quantity and
quality of per head availability of existing facilities like education, health,
employment, housing, nutrition and various infrastructures.

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2. Brain-Drain: the migration of persons born, educated and trained in developing
countries to the developed countries is also a challenge for human capital formation.
3. Lack of manpower planning: there is insufficient man power planning in less
developing countries mainly in terms of unable to maintain standard of education at
different stages and the demand and supply of technical labour force. As a result,
many developing countries are absorbing poorly trained university graduates and
faced with the most explosive problems of discontent and frustration among
unemployed graduates.
4. Measurement of human capital growth rate: the accumulation of physical capital is
easily measurable but it is difficult to measure the growth rate of human capital.
However, the growth rate of human capital formation should be greater than the
growth rate of labour force and that of the economy. Based on some experiences, the
rate of growth of human capital should be three times that of the labour force. On the
other hand, the ratio of annual growth in human capital to annual growth in annual
national income should be as high as three to one.
5. Lowering academic standards: with their enthusiasm, developing countries are
spreading out higher education with little attention for their academic standards.
Lowering academic standards tends to lower the efficiency of mainly university
graduates employed in both public and private sectors.

5.4.2 Investment on Human Capital for Development

Education is a basic objective of development in that is essential for a satisfying and
rewarding life and thus to expand human capabilities that lie at the heart of the meaning of
development. At the same time, education plays a key role in the ability of a developing
country to absorb modern technology and to develop the capacity for self-sustaining
growth and development.

The two human capital issues – education and health – are treated together because of their
close relationship. The connections between health and education include similar
analytical treatment, because both are forms of human capital. They are interlinked as we
have observed the impacts of health spending on the effectiveness of the educational
system and vice versa; and the fundamental fact that when we speak of investing in a
person’s health and investing in a person’s education, we are after all talking about the
same person. Income on the one hand and health and education on the other hand need

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their own separate attention. Despite their close relationship, you will see that higher
household income is no guarantee of improved health and education: Human capital must
be given direct attention in its own right, even in economies that are growing rapidly. In
this section, however, the role of investment on education, as one part of human capital,
for economic development has been given a special emphasis. Although the focus is on
educational investment, the same theories and principles applies to health investment.

Figure 5.1 Age-earnings profiles by level of education: Venezuela, 1989

Regarding the impact of investment in education on annual income, the impact of human
capital investments in developing countries can be quite substantial. Figure 5.1 shows the
age-earnings profiles by levels of education in Venezuela. The chart shows how incomes
vary over the life cycle for people with various levels of education. Note that those with
higher levels of education start full-time work at a later age, but as the graph shows, their
incomes quickly outpace those who started working earlier. But such future income gains
from education must be compared with the total costs incurred to understand the value of
human capital as an investment. Education costs include any direct tuition or other
expenditures specifically related to education, such as books and required school uniforms,
and indirect costs, primarily income forgone because the student could not work while in
school. Formally, the income gains (Y) can be written as follows, where E is income with
extra education, N is income without extra education, t is year, i is the discount rate, and
the summation is over expected years of working life:
Et  N t
Y 
1  i t

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An analogous formula applies to health (such as improved nutritional status), with the
direct and indirect cost of resources devoted to health compared with the extra income
gained in the future as a result of higher health status. Figure 5.2 provides a typical
schematic representation of the trade-offs involved in the decision to continue in school. It
is assumed that the individual works from the time he or she finishes school until he or she
is unable to work or die. This is taken to be 66 years.

Figure 5.2 Financial trade-offs in the decision to continue in school

Two earnings profiles are presented—for workers with primary school but no secondary
education and for those with a full secondary (but no higher) education. Primary graduates
are assumed to begin work at age 13, secondary graduates at age 17. For an individual in a
developing country deciding whether to go on from primary to secondary education, four
years of income are forgone. This is the indirect cost, as labeled in the diagram. The child
may work part time, a possibility ignored here for simplicity, but if so, only part of the
indirect-cost area applies. There is also a direct cost, such as fees, school uniforms, books,
and other expenditures that would not have been made if the individual had left school at
the end of the primary grades. Over the rest of the person’s life, he or she makes more
money each year than would have been earned with only a primary education. This
differential is labeled “Benefits” in the diagram. Before comparing costs with benefits,

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note that a dollar today is worth more to an individual than a dollar in the future, so those
future income gains must be discounted accordingly, as is done in Equation 5.1. In present
value calculations, the discount rate refers to the annual rate at which future values are
decreased to make them comparable to values in the present. The rate of return will be
higher whenever the discount rate is lower, the direct or indirect costs are lower, or the
benefits are higher.

Relationship between educational investment and development further needs the political
economy of educational supply and demand. Much of the literature and public discussion
about education and economic development in general, and education and employment in
particular, revolves around two fundamental economic processes: (1) the interaction
between economically motivated demands and politically responsive supplies in
determining how many quality school places are provided and who gets access to these
places (2) the important distinction between social and private benefits and costs of
different levels of education and the implications of these differentials for educational
investment strategy.

The amount of schooling received by an individual, although affected by many nonmarket

factors, can be regarded as largely determined by demand and supply, like any other
commodity or service. On the demand side, the two principal influences on the amount of
schooling desired are (1) private benefits of education – The benefits that accrue directly
to an individual economic unit. For example, private benefits of education are those that
directly accrue to a student and his or her family. (2) Private costs – the direct and indirect
costs that a student or family must bear.

On the supply side, the quantity of school places at the primary, secondary, and university
levels is determined largely by political processes, often unrelated to economic criteria.
Given mounting political pressure throughout the developing world for greater numbers of
school places at higher levels, we can for convenience assume that the public supply of
these places is fixed by the level of government educational expenditures.

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5.4.3 Social versus Private Benefits and Costs
Social costs of education refers to the opportunity cost to society as a whole resulting from
the need to finance costly educational expansion at higher levels when these limited funds
might be more productively used in other sectors of the economy. In contrast, social
benefits of education is Benefits of the schooling of individuals, including those that
accrue to others or even to the entire society, such as the benefits of a more literate
workforce and citizenry. Private costs of education refers to costs those borne by students
themselves. Typically in developing countries, social costs of education increases rapidly
as students climb the educational ladder. But the private cost increase more slowly or may
even decline. On the other hand, private benefits of education – The benefits that accrue
directly to an individual economic unit. For example, private benefits of education are
those that directly accrue to a student and his or her family.

Figure 5.3 Private versus social benefits and costs of education

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This widening gap between social and private costs provides an even greater stimulus to
the demand for higher education than it does for education at lower levels. Figure 5.3
provides an illustration of this divergence between private and social benefits and costs. In
Figure 5.3a, expected private returns and actual private costs are plotted against years of
completed schooling. As a student completes more and more years of schooling, expected
private returns grow at a much faster rate than private costs, for reasons explained earlier.
To maximize the difference between expected benefits and costs (and thereby the private
rate of return to investment in education), the optimal strategy for a student would be to
secure as much schooling as possible. Now consider Figure 5.3b, where social returns and
social costs are plotted against years of schooling.

The social benefits curve rises sharply at first, reflecting the improved levels of
productivity of, say, small farmers and the self-employed that result from receipt of a basic
education and the attainment of literacy, arithmetic skills, and elementary vocational
skills. Thereafter, the marginal social benefit of additional years of schooling rises more
slowly, and the social returns curve begins to level off. By contrast, the social cost curve
shows a slow rate of growth for early years of schooling (basic education) and then a
much more rapid growth for higher levels of education.

This rapid increase in the marginal social costs of post primary education is the result both
of the much more expensive capital and recurrent costs of higher education (buildings and
equipment) and the fact that much post primary education in developing countries is
heavily subsidized. Importantly, from a social viewpoint the one that maximizes the net
social rate of return to educational investment would be one that focuses on providing all
students with at least B years of schooling. Beyond B years, marginal social costs exceed
marginal social benefits, so additional public educational investment in new, higher-level
school places will yield a negative net social rate of return. The problem of divergent
social versus private benefits and costs has been artificially created by inappropriate public
and private policies with regard to wage differentials, educational selectivity, and the
pricing of educational services. As a result, private calculations of the value of education
exceed its social value, which must take account of unemployment.

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